European Banking Authority Reports on the Credit Risk Mitigation Framework

The European Banking Authority has published a report following its assessment of the credit risk mitigation framework under the Capital Requirements Regulation. Credit risk mitigation is defined in the CRR as a "technique used by an institution to reduce the credit risk associated with an exposure or exposures which that institution continues to hold". The incentive for institutions in using CRM techniques is that CRM can attract a reduction in capital requirements.

This CRM report forms the fourth and final phase of the EBA's roadmap for the implementation of the regulatory review of the internal models based approach. That roadmap, launched in February 2016, favoured continued use of the IRB approach (that is, the Foundation IRB Approach and the Advanced IRB Approach) and set out plans for the introduction, in four phases, of changes which aim at harmonizing definitions and supervisory practices in the definition of default, the estimation of risk parameters and treatment of defaulted assets, credit risk mitigation techniques and disclosure in four phases.

The EBA considers that increased clarity of the CRM framework is an integral part of the IRB review and the EBA has analyzed, in the CRM report, whether an overhaul of the CRM framework as presented in the CRR would be beneficial. The CRM report is divided into three parts which set out:

(i) A description of the CRM provisions under the current CRR, to map the articles in the CRR that contain the provisions for the techniques, eligibility and methods institutions can use for CRM. The aim of this mapping exercise is to shed light on the CRM framework as provided in the CRR, as stakeholders have raised concerns regarding the clarity of the framework as currently worded.

(ii) An overview of the use of CRM at EU level, based on data collection carried out among national regulators in April 2017. The overview considers the types of collateral and CRM techniques used by EU credit institutions for the purposes of calculating capital requirements for credit risk under the Standardized Approach and the F-IRB Approach.

(iii) A section on policy-related aspects on CRM, in two parts: (1) the outcome of a stocktake exercise regarding national provisions in the area of CRM, and (2) CRM-related policy issues identified by the EBA which call for amendments of the CRR text.

The CRM report sets out only limited guidance on the use of CRM for exposures under the A-IRB approach. The EBA will conduct further work on this topic to develop a set of guidelines on the use of CRM under the A-IRB approach and may make separate recommendations on changes to the CRM framework in the CRR. This approach will provide more detailed guidance for A-IRB and is likely to involve further consultation and engagement with the industry.

The CRM report also sets out the EBA's view of the three CRM-related mandates it has been given under the CRR. These require it to produce Regulatory Technical Standards on the recognition of conditional guarantees, on liquid assets and on the IRB approach for master netting agreements. In the EBA's view, there would be limited benefit, and potentially disproportionate regulatory outcomes were the EBA to fulfil the three mandates, because they only cover specific aspects of the regulatory framework, which are not expected to have a significant impact on the calculation of capital requirements for credit risk by institutions nor on their rating systems. The EBA proposes that the mandate for RTS on liquid assets should be deleted from the CRR and that it should continue to monitor the need to deliver on the other two mandates in light of international developments in this regulatory area.

View the CRM report.